What is my tax liability?

Tax liability is a normal part of life for anyone who earns an income. It’s important to know how much you owe to ensure you’re paying the correct amount. Not only that, but you can apply different means that bring down the amount and put more money in your pocket. Let’s go through the most common types of tax liability: income and capital gains.

What is Tax Liability?

Tax liability is the money you owe to the Federal Government, state government, or local tax authority, though it’s usually owed to the Internal Revenue Service (IRS). Companies and individuals both have tax liabilities.

It’s called a liability because it’s essentially a debt you owe. It is part of your responsibility as a US citizen to give part of your income to the government to help pay for things like infrastructure and the military. That debt can be from the income you’ve made in the year the tax is owed but also from other years if you haven’t paid those taxes yet.

Different sources of income are liable for tax. Whether the money comes from a job, something you own that you get income from in return (like a rental property), or from selling an asset. But that doesn’t mean everyone has a tax liability. Some Americans don’t meet the requirements to owe tax to the IRS, but they will still pay it through local taxes and the goods they purchase.

How to calculate your tax liability

The most familiar tax liability for Americans is income. If you’re employed, your employer will take money from your income and pay this to the IRS before you receive your pay packet. But it’s still wise to calculate what you owe so that you can make sure their calculations are correct.

The amount you owe is based on your income and filing status, based on your personal situation. The system is progressive, meaning there are brackets that determine the rate you pay. Income that falls within each bracket is charged at a set rate. There are also standard deductions that aren’t liable for tax.

In 2023, the federal income tax standard deductions are as follows:

So, if you’re a single filer, you won’t pay tax on the first $13,850 you owe in each tax year.

After deducting these amounts, the rest of your income is charged at the following rates:

A single filer earns $56,000. The first $13,850 doesn't attract tax, meaning it is only owed on $42,150.

Up to $11,000 is charged at ten percent, which is £1,100. That leaves $31,150 over $11,000 but under $44,725, so this chunk is charged at 12 percent, which is $3,738. That means the total liability is $1,100 plus $3,738, equaling $4,838.

If you're unsure of your liability, a financial advisor can help.

Tax Liability for Capital Gains

If you sell a high-value asset, like a second property or an investment, you'll also be liable to pay tax on the money you've made. This is known as capital gains tax liability, which you owe for the year you receive the income.

The amount of capital gains tax you owe depends on how long you've owned the asset. If you've owned it for less than one year, the gain is classed as short-term and counts as income. Then, you lump that with your other income sources to work out your liability. If you've held the asset for more than one year, it counts as a long-term gain and follows its own system, but it is very similar to income liability.

Here are the long-term capital gains liability rates for 2023:

Capital gains liability doesn’t apply to everything you sell, though. For example, if you’re selling your primary residence (meaning the main home you live in), single filers are only liable to pay tax on any profit over $250,000. For married couples, that minimum threshold is $500,000. So, most Americans selling their homes don’t need to worry about this tax.

How to Reduce Your Tax Liability

Although tax is a fact of life for most people, there are ways to reduce your liability. You can:

Your employer uses your W-4 form to determine which tax rate applies to you so they know how much income to withhold for the IRS. If your employment status changes, your personal situation changes, or you suspect you may be overpaying, you can ask your employer to review your W-4 with you.

Some expenses or credits you are entitled to can be offset by your tax and reduce the amount you owe. Expenses you make, for example, using your car for work, healthcare payments, or costs you’ve covered for your company, can be deducted from your income tax liability.

Payments you make towards your retirement savings, including a 401(k) and an IRA, can reduce the amount of income you’re liable to pay tax on. But it’s important to contribute to the most tax-efficient savings pot for your plans.

If you’re likely to be in a lower tax bracket when you retire than you are now, it can make the most sense to contribute to a traditional IRA, where your taxes are deferred until you retire. However, a Roth IRA could work better if you’re likely to retire in a higher tax bracket because withdrawals are tax-free.

Understanding your tax liability is important to make sure you’re not overpaying. If you want to make your income as tax efficient as possible for your situation now and in the future, a financial advisor can set you up for success.